A chapter 7 bankruptcy trustee brought an adversary proceeding against a buyer and its designated purchaser for breach of contract and civil contempt. The defendants raised various defenses, including frustration of purpose – arguing that DHL’s failure to perform under a shipping contract with the debtor that was part of the acquired assets discharged the defendants from further performance under the sale agreement. Not surprisingly, that argument did not fly with the bankruptcy court.
The trustee accepted an offer of C.A. Acquisition Corp. (Acquisition) and obtained a bankruptcy court order authorizing the private sale of substantially all of the debtor’s assets. The trustee also obtained court permission for Acquisition to manage the debtor’s business until the sale could be closed. An auction was held to obtain competing bids, and Acquisition was the winning bidder.
Under the terms of the sale, the assets were to be purchased by Acquisition or its “nominee” for a purchase price of $161,500 cash at closing plus an earn-out based on one percent of gross revenue, with minimum required payments of $25,000 and $125,000 for the two years following closing. Acquisition designated C.A. Acquisition Newco, LLC (Newco) as purchaser, as reflected in the bill of sale – which included standard language that “the transferee accepts the subject assets ‘as is,’ ‘where is,’ and ‘with all faults.’”
One of the acquired assets was a shipping contract with the logistics company DHL. However, DHL ceased operations in the U.S. and stopped performing under the contract shortly after the sale.
The trustee brought a complaint against Acquisition, Newco and a third company (whose relevance was unclear) based on breach of contract for the failure to make the first year’s earn-out payment and failure to submit quarterly revenue reports. It also alleged anticipatory breach for failure to pay the second year’s earn-out. (By the time the court issued its opinion, this had become an actual as opposed to anticipatory breach.)
The defendants relied primarily on the defense of “frustration of purpose” of the contract. They contended that the DHL contract was the only profitable asset, and it became valueless when DHL ceased operations in the U.S. They also tried to argue that the assignment to Newco released Acquisition from liability. Finally they contended the trustee had a duty to assist Newco in its claims against DHL, and the trustee’s failure to do so should excuse the defendants from compliance with the sale agreement.
With respect to frustration of purpose, the defendants argued that (1) obtaining the DHL contract was a principal purpose of the sale agreement, (2) the frustration of purpose as a result of DHL’s nonperformance was substantial, and (3) the “nonoccurrence of the frustrating event” was a basic assumption underlying the contract.
As an initial point, the court took issue with the contention that acquiring the DHL contract was the principal purpose for the purchase agreement. It found no support in the language of the sale agreement or other documents, and was not willing to infer this purpose based on the defendants’ contention that the contract was the only asset that generated profit at the time of the purchase – since, among other things, that did not mean the contract was the only asset with value.
More importantly, under applicable state law frustration of purpose may discharge a party from liability “unless the language or the circumstances indicate the contrary.” In this case, the sale was expressly “as is,” “where is,” and “with all faults.” Further, Acquisition had an opportunity to manage the business prior to the sale, which gave it an opportunity to perform due diligence with respect to the debtor’s assets. Under these circumstances, the court concluded that a frustration of purpose defense was not available.
The defendants also contended that the trustee had a duty to assist them in protecting Newco’s rights under the DHL contract, and his failure to do so excused them from further performance. According to them, DHL wrongfully terminated and the trustee should have actively assisted in compelling performance. However, there was no express obligation to assist, and they gave no other basis for the purported duty.
The defendants finally argued that Acquisition should not be liable because Newco was not merely a nominee but rather became the actual purchaser of the assets. However, there was nothing that released Acquisition from liability or excused it from performance, regardless of whether title was transferred to Acquisition or Newco. Consequently, the court found Acquisition and Newco jointly and severally liable for the full $150,000 in earn-out payments.
At least the court did not hold the defendants in contempt for failure to comply with the sale agreement and court order. This issue turned primarily on an obligation to provide quarterly revenue reports. The defendants submitted bank statements in lieu of revenue reports for most of the applicable periods. However, contempt requires that a party “must have violated a clear and unambiguous order that left no reasonable doubt as to what behavior was expected and who was expected to behave in the indicated fashion.” Providing some information was sufficient to cause the court to refrain from holding the defendants in contempt.
Generally bankruptcy sales are governed by the rule of “caveat emptor.” A good rule of thumb is that once you buy assets from a chapter 7 trustee, the assets are yours; and if you discover problems with the assets, it will do little good to look to the trustee or the bankruptcy estate for relief.
Vicki R. Harding, Esq.